David C. Hutchinson v. Commissioner , 116 T.C. No. 14 ( 2001 )

116 T.C. No. 14
UNITED STATES TAX COURT
DAVID C. HUTCHINSON, ET AL.,1 Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 15912-98, 15958-98, Filed March 14, 2001.
15959-98, 15960-98.
Held: Under the alternative cost method of Rev.
Proc. 92-29, 1992-1 C.B. 748, a real estate developer
may allocate to its bases in lots sold $3,707,662 in
estimated construction costs relating to common
improvements.
Held, further, $5,861,595 in estimated, future-
period interest expense relating to common improvements
does not qualify under the alternative cost method for
allocation to the developer’s bases in lots sold.
Neil D. Kimmelfield, for petitioners.
Gerald W. Douglas and Nhi T. Luu-Sanders, for respondent.
1
Cases of the following petitioners are consolidated
herewith: Isaac M. Kalisvaart and Francien Kalisvaart-Valk,
docket No. 15958-98; William T. Criswell and Sharon L. Criswell,
docket No. 15959-98; Robert S. Bobosky and Judeen M. Bobosky,
docket No. 15960-98.
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OPINION
SWIFT, Judge: These cases were consolidated for trial,
briefing, and opinion. For 1994, respondent determined the
following deficiencies in petitioners’ Federal income tax:
Petitioners Deficiency
David C. Hutchinson $442,746
Isaac M. Kalisvaart and Francien Kalisvaart-Valk 358,095
William T. and Sharon L. Criswell 188,862
Robert S. and Judeen M. Bobosky 128,054
The issues for decision involve whether, under the
alternative cost method of Rev. Proc. 92-29, 1992-1 C.B. 748
(Rev. Proc. 92-29), a real estate developer, in calculating gain
on the sale of residential lots sold in 1994, may allocate to the
developer’s bases in the lots sold estimated construction costs
relating to certain common improvements to the development and
whether the developer may include, in the calculation of
estimated construction costs, estimated, future-period interest
expense relating to the common improvements.
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for 1994, and all Rule
references are to the Tax Court Rules of Practice and Procedure.
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Background
These cases were submitted fully stipulated under Rule 122,
and the stipulated facts are so found.
At the time the petitions were filed, petitioners resided in
the following locations:
Petitioners Location
David Hutchinson Ketchum, Idaho
Isaac Kalisvaart and Francien Kalisvaart-Valk Portland, Oregon
William and Sharon Criswell Wellington, Florida
Robert and Judeen Bobosky Portland, Oregon
On June 21, 1993, petitioners formed Valley Ranch, Inc.
(VRI) as an Idaho corporation, and petitioners elected to have
VRI taxed pursuant to subchapter S of the Internal Revenue Code.
Petitioners constitute all of the shareholders of VRI.
On December 1, 1993, VRI entered into an option to purchase
a 526-acre parcel of partially developed real estate near Sun
Valley, Idaho (the Property). Prior to December 1, 1993, the
sellers of the Property had begun development of the Property as
a golf course residential community.
Also on December 1, 1993, VRI entered into an agreement with
the sellers of the Property for VRI to continue to develop the
Property as follows:
Acreage Use
189 Acres 99 residential lots
162 Acres Hale Irwin designed golf course
175 Acres Roads and common areas
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On May 5, 1994, the final plat was recorded for development
of the Property as a golf course residential community, and VRI
exercised its option and entered into a binding agreement with
the sellers to purchase the Property for a total purchase price
of $5,715,345.2
Beginning in May of 1994 and thereafter through the time
these cases were submitted to the Court for decision in February
of 2000, VRI improved and sold residential building lots on the
Property and realized the sales proceeds therefrom.
Also on May 5, 1994, VRI entered into a contract (the
Contract) with Valley Club, Inc. (VCI), a nonprofit Idaho
membership corporation whose members would purchase memberships
in the golf club. Under the Contract, VRI reaffirmed its
obligation to construct on the Property an 18-hole golf course, a
driving range, and two practice putting greens. Hereinafter, we
refer to these nondepreciable improvements that VRI was obligated
to construct on the Property as “the Golf Course”.
Under the May 5, 1994, Contract between VRI and VCI, VRI
also obligated itself to construct on the Property a golf
clubhouse with a restaurant and bar facilities, a golf pro shop,
2
The total purchase price reflected $2,941,000 paid in cash
and a $2.5 million promissory note in favor of the sellers of the
Property. The $274,345 balance of the total purchase price
reflected fees and closing costs associated with purchase of the
Property.
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golf course maintenance facilities, men’s and women’s locker
rooms, an outdoor swimming pool, and four tennis courts.
Hereinafter, we refer to these depreciable improvements that VRI
was obligated to construct on the Property as “the Clubhouse”.
Under the Contract between VRI and VCI, ownership of the
completed Golf Course and the Clubhouse was to be transferred to
VCI, and VCI was to establish and operate a golf membership club
(the Club) which would sell memberships in the Club to homeowners
within the Golf Course community and to members of the public.
Under the Contract, in consideration for the transfer to VCI
of VRI’s ownership interest in the Golf Course and in the
Clubhouse that were to be constructed by VRI, VCI, among other
things, was obligated to pay to VRI the total fees that would be
received by VCI upon the sale by VCI of memberships in the Club.
In order to secure the respective rights and obligations of
VRI and VCI under the Contract, during construction of the Golf
Course and the Clubhouse, the deed executed by VRI transferring
the Golf Course and the Clubhouse to VCI was to be transferred
into escrow, and the membership fees, upon receipt by VCI, were
to be transferred by VCI into an escrow account.
The deed to the Golf Course and the Clubhouse was to be
transferred out of escrow to VCI on the earlier of December 31,
2000, or when at least 25 charter memberships, 375 golf
memberships, and 100 golf social memberships in the Club were
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sold. The membership fees held in escrow were to be transferred
out of escrow to VRI according to the following schedule:
Fees in escrow to be transferred Schedule
1/3 Upon completion of 9 holes of the Golf Course
1/3 Upon completion of the Golf Course
1/3 Upon completion of the Clubhouse
After completion of construction of the Golf Course and the
Clubhouse, fees received by VCI upon sale of additional
memberships in the Club would be transferred directly to VRI as
further compensation to VRI for transfer to VCI of ownership of
the Golf Course and the Clubhouse.
In 1994, VRI began construction of the Golf Course and the
Clubhouse, and VRI proceeded to sell the residential lots on the
Property. New owners of the residential lots, or their
contractors, began building homes on the lots, and VCI proceeded
to sell memberships in the Club.
Prior to construction, VRI estimated its total costs to
construct the Golf Course and the Clubhouse (not including VRI’s
$5,715,345 initial purchase price for the Property) as follows:
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Estimated Costs
The Golf Course $13,390,624
The Clubhouse 3,707,662
Employee Housing 375,0001
Finance Costs 5,861,5952
Total Estimated Costs $23,334,881
___________________
1
The costs of employee housing are not in dispute.
2
Total estimated finance costs relating to both the Golf Course and
the Clubhouse equaled $7,022,000. The $5,861,595 set forth above
represents the difference between the $7,022,000 total estimated
finance costs and the $1,160,405 actual finance costs incurred by
VRI in 1994.
VRI undertook substantial interest-bearing debt obligations
in connection with the construction of the Golf Course and the
Clubhouse.
On July 10, 1996, prior to completion of the Golf Course and
the Clubhouse, VRI executed in favor of VCI and transferred into
escrow, a deed with respect to ownership of the Golf Course and
the Clubhouse.
In the summer of 1996, construction of the Golf Course and
the Clubhouse was completed by VRI.
On July 19, 1996, the Golf Course and the Clubhouse opened
and play began.
Also on July 19, 1996, upon completion of construction of
the Golf Course and the Clubhouse, apparently because VCI had not
sold the required number of Club memberships, the deed to the
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Golf Course and the Clubhouse was not transferred out of escrow
to VCI.
Also because VCI had not sold the required number of
memberships, pursuant to the Contract, during the balance of
1996, 1997, 1998, and until April 21, 1999, VRI managed and
operated the Golf Course and the Clubhouse on behalf of VCI. We
refer to this period of time (namely, the period of time after
completion of the Golf Course and the Clubhouse during which VRI
continued to manage and operate the Golf Course and the
Clubhouse) as the “transition period”.
Under the Contract, during the transition period, VRI
realized the profits and losses relating to operation of the Golf
Course and the Clubhouse. The bylaws of VCI, however, limited
the amount of annual dues (as distinguished from membership fees)
that could be collected from Club members to pay for operation of
the Golf Course and the Clubhouse, and cumulative losses of
approximately $994,393 were realized by VRI during the transition
period in connection with VRI’s operation of the Golf Course and
the Clubhouse. The operational losses apparently were caused by
the fact that the member base in the Club was not yet large
enough to generate sufficient dues and other revenue to cover the
operating expenses.
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During the transition period, VCI, not VRI, was responsible
for decisions and costs of any further improvements made to the
Golf Course and to the Clubhouse.
Up until July 19, 1996, the day the Golf Course and the
Clubhouse opened, all property-related insurance relating to the
Golf Course and the Clubhouse was paid by VRI. After July 19,
1996, VCI paid all property-related insurance relating to the
Golf Course and the Clubhouse.
Under the Contract, any increase or decrease in the
underlying fair market value of the Golf Course and the Clubhouse
that occurred during the transition period, would accrue, not to
VRI, but to VCI.
In 1997, because of potential conflicts of interest between
VRI and the board of directors of VRI, some members of the Club,
individually and on behalf of VCI, filed a lawsuit against VRI
and the individual owners of VRI (namely, petitioners). One of
the issues in the lawsuit involved the validity of the Contract.
On April 21, 1999, VRI, petitioners, VCI, and members of VCI
arrived at a comprehensive settlement of the above lawsuit.
Pursuant to the settlement, on April 21, 1999, VRI turned over to
VCI operation and management of the Golf Course and the
Clubhouse, and the deed and legal title to the Golf Course and
the Clubhouse were transferred out of escrow to VCI.
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VRI’s 1994 U.S. Income Tax Return for an S Corp. (Form
1120S) was prepared using the alternative cost method under Rev.
Proc. 92-29, to allocate a ratable portion of the following total
actual and estimated costs to VRI’s cost bases in all of the
residential lots on the Property:
Total Actual and Estimated Costs and Expenses to be Allocated Amount
VRI’s total actual acquisition costs for the Property $ 5,715,345
VRI’s total estimated construction costs for the Golf Course 13,390,624
VRI’s total estimated construction costs for the Clubhouse 3,707,662
VRI’s total actual 1994 interest expense relating to both the
the Golf Course and the Clubhouse 1,160,405
VRI’s total estimated post-1994 interest expense relating to
the Golf Course and the Clubhouse 5,861,595
Total $29,835,631
On VRI’s 1994 Federal income tax return, in computing its
gain on the residential lots sold in 1994, VRI computed its cost
bases in the lots based on an allocation of the above total
actual and estimated costs for the Golf Course and the Clubhouse,
thereby reducing VRI’s reported gain for 1994 with respect to the
lots sold.
During the transition period, on VRI’s 1996, 1997, 1998, and
1999 Federal income tax returns for an S Corp., VRI apparently
did not claim any depreciation deductions with respect to its
costs of constructing the Golf Course and the Clubhouse.
In the statutory notice of deficiency, respondent treated
VRI’s development and sale of the residential lots on the
Property as a project separate from VRI’s construction of both
the Golf Course and the Clubhouse, and therefore respondent
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disallowed VRI’s allocation, under the alternative cost method,
of the total estimated costs of constructing the Golf Course and
the Clubhouse to VRI’s cost bases in the residential lots sold in
1994.
Shortly before trial herein was scheduled to take place,
however, respondent abandoned his contention that the Golf Course
and the Clubhouse constituted projects separate from VRI’s
development and sale of the residential lots. Respondent
acknowledged that the Golf Course and the Clubhouse constituted a
single project integrated with VRI’s development and sale of
improved residential lots. Respondent acknowledged that VRI
could allocate under the alternative cost method the estimated
costs of constructing the Golf Course to the lots sold.
Respondent, however, for the first time in a pretrial brief
contended that VRI had retained an ownership interest in the
Clubhouse in 1994 and through the transition period, and
therefore that the estimated construction costs of the Clubhouse
would have been recoverable to VRI through depreciation and did
not qualify under the alternative cost method for allocation by
VRI to the lots sold in 1994 and in subsequent years.
More specifically, with respect to VRI’s $13,390,624 in
total estimated construction costs of the Golf Course (all of
which related to nondepreciable improvements to the Property),
respondent acknowledged that those estimated costs qualified
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under the alternative cost method and were properly allocated by
VRI to the lots sold in 1994 and in subsequent years.
With respect, however, to VRI’s $3,707,662 in total
estimated construction costs of the Clubhouse (all of which
related to depreciable improvements to the Property), respondent
concluded that VRI’s alleged retained ownership of the Clubhouse
before and during the transition period (during which time VRI
allegedly would have been able to recover its costs thereof
through depreciation) disqualified VRI from using the alternative
cost method to allocate to the lots sold the estimated Clubhouse
construction costs.
Further, respondent concluded that VRI’s $5,861,595 in
estimated future-period interest expense with respect to its debt
obligations relating both to the Golf Course and to the Clubhouse
did not qualify as estimated construction costs under the
alternative cost method and could not be allocated to the cost of
the lots sold.
Procedurally, petitioners do not object to respondent’s
change in position and to respondent’s new contentions regarding
VRI’s use of the alternative cost method for its estimated
Clubhouse construction costs and estimated interest expense
relating to the Golf Course and to the Clubhouse. Petitioners,
however, argue that respondent should have the burden of proof
regarding any underlying factual disputes relating to
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respondent’s new contentions. Respondent counters that under our
Rules the new contentions should be treated only as new theories,
not as new issues, and that the burden of proof should remain
with petitioners on all factual matters.
Discussion
Generally, under Rev. Proc. 75-25, 1975-1 C.B. 720 (Rev.
Proc. 75-25), a real estate developer was allowed, in the first
year of construction of a development, to allocate to the
developer’s cost bases in separate lots to be sold certain
estimated construction costs of improvements common to the entire
development. The purpose of Rev. Proc. 75-25 was to allow a real
estate developer to spread more evenly and fairly the amount of
the developer’s gain or loss relating to a real estate
development over the years of construction. By allocating, at
the beginning of a development, estimated construction costs
relating to common improvements to the developer’s cost bases in
lots to be sold, a developer was able to recognize less income in
the early years of a development as lots were being sold (as a
result of the increased cost bases in the lots on which the
developer’s taxable gain was computed).
In Herzog Bldg. Corp. v. Commissioner, 44 T.C. 694, 702-703
(1965), involving a predecessor ruling to Rev. Proc. 75-25,3 we
3
Mim. 4027, XII-1 C.B. 60 (1933).
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explained the purpose and application of the alternative cost
method as follows:
Where a developer is bound by contract to
make certain improvements for the benefit of
the property sold, the fact that the
expenditure required to install the
improvement is not made during the taxable
period within which part of the property is
sold should not prevent an aliquot portion of
the cost from being offset against the profit
from the sale of the property. [Citation
omitted.]
To qualify under Rev. Proc. 75-25, among other requirements,
a developer had to have a contractual obligation to provide the
common improvement costs which were to be estimated and
allocated, and the common improvements could not be recoverable
by the developer through depreciation.
In 1984, Congress enacted sec. 461(h) to postpone the
deductibility to taxpayers of many costs until “economic
performance” occurs. Deficit Reduction Act of 1984, Pub. L. 98-
369, 98 Stat. 598. Generally, under section 461(h), if property
or services are to be provided by taxpayers, economic performance
is not regarded as having occurred until the taxpayers actually
incur the costs of providing the property or services.
Proposed regulations under section 461(h) were issued on
June 7, 1990, and adopted on April 9, 1992. See 55 Fed. Reg.
23235 (June 7, 1990), 57 Fed. Reg. 12411 (April 10, 1992). The
preamble to the section 461(h) regulations, as proposed,
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explained that, because under section 461(h) economic performance
was required in order for costs to be deducted, a real estate
developer would no longer be allowed to allocate estimated future
construction costs to the developer’s bases in lots sold. See
Notice 91-4, 1991-1 C.B. 315. Thus, it appeared that the
economic performance rules of 461(h) would effectively override
the alternative cost method available to developers under Rev.
Proc. 75-25.
On January 11, 1991, however, respondent issued Notice 91-4,
1991-1 C.B. 315, in which respondent provided that, in spite of
the economic performance rule of section 461(h), the alternative
cost method under Rev. Proc. 75-25 would continue generally to be
available to developers of real estate until additional guidance
from respondent was provided.
On April 9, 1992, the above regulations under section 461(h)
were finalized, but the referenced language in the preamble to
the proposed regulations was eliminated. See regulations under
sec. 461.
Also, on April 9, 1992, respondent issued Rev. Proc. 92-29,
1992-1 C.B. 748, in which a limited version of the alternative
cost method was provided. Under the alternative cost method
provided in Rev. Proc. 92-29, a real estate developer was
permitted to continue to allocate to lots sold the estimated
future construction costs relating to common improvements without
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regard to whether the costs would qualify as incurred under the
economic performance rule of section 461(h), but the amount of
such costs that would qualify for this allocation was limited in
any 1 year to the total cumulative amount of actual construction
costs for common improvements that, as of the end of each year,
the developer had incurred in the entire development.
Under Rev. Proc. 92-29, as under Rev. Proc. 75-25, use of
the alternative cost method was limited to estimated costs of the
common improvements that the developer was contractually
obligated to construct in the development and that would not be
recoverable by the developer through depreciation. The limited
alternative cost method as set forth in Rev. Proc. 92-29 applies
to the year before us in these cases.
$3,707,662 in Estimated Clubhouse Construction Costs
The disagreement between the parties regarding allocation of
VRI’s estimated Clubhouse construction costs under the
alternative cost method centers on whether VRI, at any time,
would have been able to recover its actual construction costs in
the Clubhouse through depreciation. See Rev. Proc. 92-29,
sec. 2.01, 1992-1 C.B. 748, 749.
Petitioners contend that at no time during construction of
the Clubhouse beginning in 1994 and after construction through
the transition period would VRI have had the right to recover its
Clubhouse construction costs through depreciation.
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Petitioners also contend that the issue of whether VRI’s
Clubhouse construction costs would have been recoverable by VRI
through depreciation represents a new factual issue under Rule
142(a) and that respondent should bear the burden of proof with
regard thereto.
Respondent contends that ownership of the Clubhouse was held
by VRI during construction from 1994 through the transition
period and until April 21, 1999, when the deed to the Golf Course
and to the Clubhouse was transferred out of escrow to VCI, and
therefore that VRI had a depreciable interest in the Clubhouse.
Generally, for the years in issue, the burden of proof is on
the taxpayer with regard to factual issues. Rule 142(a),
however, states that in the case of any “new matter” the burden
of proof shall be upon respondent. In Wayne Bolt & Nut Co. v.
Commissioner, 93 T.C. 500, 507 (1989), we summarized the
distinction between new theories that are treated as new issues
and new theories that simply supplement previously raised issues
as follows:
A new theory that is presented to sustain a
deficiency is treated as a new matter when it either
alters the original deficiency or requires the
presentation of different evidence. A new theory which
merely clarifies or develops the original determination
is not a new matter in respect of which respondent
bears the burden of proof. [Citations omitted.]
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In respondent’s notices of deficiency to petitioners,
respondent determined that the development and sale of VRI’s
residential lots, on the one hand, and the Golf Course and
Clubhouse, on the other hand, constituted two separate
development projects (i.e., that the Golf Course and Clubhouse
were not improvements common to the development of the
residential lots) and that VRI therefore could not, under the
alternative cost method, allocate to the residential lots the
costs of constructing the Golf Course and the Clubhouse.
As explained, in respondent’s pretrial memorandum,
respondent abandoned the contention that the residential lots,
the Golf Course, and the Clubhouse constituted separate projects,
and for the first time respondent contended that VRI, not VCI,
owned the completed Clubhouse, had a depreciable interest in the
Clubhouse, and would have been able to recover its actual
construction costs through depreciation, and therefore that VRI
could not use the alternative cost method to allocate its
estimated Clubhouse construction costs to its bases in the
residential lots.
The evidence relevant to whether development of the
residential lots, the Golf Course, and the Clubhouse constituted
a single project is quite different from the evidence required of
petitioners to prove, as between VRI and VCI, ownership of, and
the existence of a depreciable interest in, the Clubhouse.
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Respondent’s new theory constitutes a new, different matter, not
just another version of an issue or an adjustment previously
raised in a notice of deficiency, and respondent bears the burden
of proof regarding this fact issue. See Barton v. Commissioner,
993 F.2d 233 (11th Cir. 1993), affg. without published opinion
T.C. Memo. 1992-118; Abatti v. Commissioner, 644 F.2d 1385, 1390
(9th Cir. 1981), revg. T.C. Memo. 1978-392; see also sec. 7522;
Shea v. Commissioner, 112 T.C. 183 (1999).
The period for depreciation of property begins when property
is placed in service. See sec. 1.167(a)-10(b), Income Tax Regs.
Accordingly, VRI’s construction costs relating to the
Clubhouse are properly regarded as recoverable through
depreciation only if, and for the period that, VRI possessed an
ownership interest in the Clubhouse after the Clubhouse was
placed in service.
Generally, property is placed in service when it reaches a
condition of readiness and availability for a specifically
assigned function. See sec. 1.167(a)-11(e)(1), Income Tax Regs.
On July 19, 1996, the Golf Course and the Clubhouse opened and
play began. Absent evidence in these cases to the contrary, and
in light of respondent’s burden of proof on this issue, we treat
July 19, 1996, as the date the Clubhouse was placed into service.
Because the Clubhouse was not placed in service until
July 19, 1996, from the time construction of the Clubhouse began
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in 1994 through July 18, 1996, VRI did not have an interest in
the Clubhouse properly recoverable through depreciation, and we
reject respondent’s contention that because VRI allegedly had an
ownership interest in the Clubhouse during construction, VRI is
not qualified to allocate estimated Clubhouse construction costs
under the alternative cost method.
The question of whether VRI would have been able to recover
its Clubhouse construction costs through depreciation because it
allegedly had a depreciable interest in the Clubhouse during the
transition period (namely, on or after the Clubhouse was placed
in service on July 19, 1996, and until April 21, 1999, the date
the deed to the Clubhouse was transferred out of escrow to VCI),
turns on an analysis of the benefits and burdens relating to
ownership of the Clubhouse during the transition period. See
Grodt & McKay Realty, Inc. v. Commissioner, 77 T.C. 1221, 1235-
1238 (1981). Who possesses the benefits and burdens of ownership
of property constitutes a question of fact which is generally
ascertained from the intentions of the parties as evidenced by
the written agreements read in light of all the relevant facts
and circumstances. See Durkin v. Commissioner, 87 T.C. 1329,
1367 (1986), affd. 872 F.2d 1271 (7th Cir. 1989).
Some of the factors used by courts in analyzing whether
taxpayers possess the benefits and burdens of ownership of
property are: (1) Who has legal title to the property; (2) whom
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the parties treat as possessing the benefits and burdens of
ownership; (3) who has equity in the property; (4) whether the
taxpayer has a present obligation to execute and deliver a deed
and whether the purchaser has a present obligation to make
payments; (5) who has the rights of possession to the property;
(6) who pays the property taxes; (7) who bears the risk of loss
or damage to the property; and (8) who receives the profits from
the operation and sale of the property. See Grodt & McKay
Realty, Inc. v. Commissioner, supra at 1237-1238.
Ownership of real property may be transferred even though
title thereto is retained by the seller or is in escrow for
security purposes. See Clodfelter v. Commissioner, 48 T.C. 694,
700 (1967), affd. 426 F.2d 1391 (9th Cir. 1970).
On July 10, 1996, prior to the time the Clubhouse was placed
in service, VRI transferred into escrow title to the Clubhouse.
Thereafter, during the transition period, title to the Clubhouse
was held in escrow in VCI’s name. VCI stood to benefit from an
increase in the fair market value of the Clubhouse, and VCI would
suffer economically for any decrease in the fair market value of
the Clubhouse.
Also during the transition period, VCI was obligated and did
pay for the insurance relating to the Clubhouse.
Transfer to VCI of legal title to the Clubhouse was
scheduled to occur no later than December 31, 2000, regardless of
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how much VRI had received in membership fees and regardless of
the amount of VRI’s losses in connection with operation of the
Clubhouse during the transition period.
Under the Contract, until transfer of title from the escrow
to VCI, VRI was required to fund any deficit and to retain any
net income from operating the Clubhouse. VCI, however, during
the transition period had control over the amount of dues charged
to members, and VCI thereby largely controlled the income or loss
to be realized from operation of the Clubhouse.
With regard specifically to a depreciable ownership interest
in property, in Commissioner v. Moore, 207 F.2d 265, 268 (9th
Cir. 1953), revg. and remanding 15 T.C. 906 (1950), the Court of
Appeals for the Ninth Circuit stated:
It is not the physical property itself, nor the
title thereto, which alone entitles the owner to claim
depreciation. The statutory allowance is available to
him whose interest in the wasting asset is such that he
would suffer an economic loss resulting from the
deterioration and physical exhaustion as it takes
place. * * *
See also Weiss v. Weiner, 279 U.S. 333 (1929); Geneva Drive-In
Theatre, Inc. v. Commissioner, 622 F.2d 995 (9th Cir. 1980).
In petitioners’ post-trial brief, petitioners accurately
summarize the transaction before us as follows:
VRI acquired the Project for a single purpose -- to
create (1) valuable homesites abutting a first-class golf
course and (2) valuable golf club memberships and to
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liquidate its entire investment in the Project at a
profit by selling the homesites and memberships. In
furtherance of that purpose, on the very day that VRI
acquired the Project, VRI also entered into a Purchase
and Sale Agreement with the Club, a non-profit membership
corporation, under which VRI irrevocably committed itself
to construct golf-related improvements and to convey
those improvements (the Club Facilities) to the Club,
retaining only the right to proceeds from the sale of a
specified number of Club memberships, and placing the
title to the Club Facilities in escrow to protect its
interest in those sale proceeds. * * *
We conclude that respondent has failed to meet his burden of
proving that, during the transition period, VRI, not VCI,
possessed the benefits and burdens of ownership of the Clubhouse.
Also, apart from the burden of proof on this fact issue, we
conclude that the evidence establishes that, during the
transition period, VCI possessed the benefits and burdens of
ownership of the Clubhouse. The estimated construction costs
associated with the Clubhouse, therefore, are not to be regarded
as recoverable by VRI through depreciation during the transition
period.
Because VRI would not be able to recover its construction
costs through depreciation during either the construction period
or the transition period, VRI’s estimated construction costs
relating to the Clubhouse may be allocated to the bases of the
residential lots sold in 1994 under the alternative cost method
of Rev. Proc. 92-29, subject to the limitations thereof.
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Respondent argues that the failure of VRI and VCI to adhere
strictly to the terms of the Contract indicates that VRI and VCI
did not regard the Contract as binding and that we should
disregard the terms of the Contract. We disagree. The deed to
the Clubhouse was transferred into escrow before the placed-in-
service date of July 19, 1996, the relevant date for purposes of
establishing in these cases ownership of and a depreciable
interest in the Clubhouse. The fact that the deed to the
Clubhouse was not transferred into escrow until shortly before
completion of construction is not particularly significant.
Also, in light of the indicia of ownership set forth above, the
fact that a formal written lease of the Clubhouse between VRI and
VCI was not executed during the transition period is not
particularly significant. We believe that the terms under which
the Clubhouse would be operated during the transition period as
between VRI and VCI were adequately set forth in the Contract,
and respondent has pointed us to nothing that represents a
failure to adhere to that agreement in any substantial way.
Respondent relies on language in the 1999 settlement
agreement between VRI, petitioners, VCI, and members of VCI as
follows:
Turnover Date is defined as of the date when all
documents necessary to carry out this agreement are
removed from escrow * * * and ownership, possession,
and control of the property * * * is actually
transferred from VRI to VCI.
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We regard use in the above settlement agreement of the term
“ownership” as simply protective and as not indicative of true
ownership of the Clubhouse. We do not find this language from
the 1999 settlement agreement arising out of a legal dispute as
controlling with respect to ownership of the Clubhouse during the
transition period.
Estimated Future-Period Interest Expense
In Rev. Proc. 92-29, sec. 4.01, 1992-1 C.B. 748, 750, in a
general explanation of the alternative cost method, reference is
made to the general capitalization rules and the interest
capitalization rules of section 263A(f) as follows:
The alternative cost method does not affect the
application of general capitalization rules to
developers of real estate. Thus, common improvement
costs incurred under section 461(h) of the Code are
allocated among the benefitted properties and may
provide the basis for additional computations (e.g.,
interest capitalization under section 263A(f)).
Petitioners contend generally that (regardless of the above
specific reference in Rev. Proc. 92-29 to the continued
application to developers of the general capitalization rules and
of the interest capitalization rule of section 263A(f)), the
history and purpose of Rev. Proc. 75-25 support their argument
that estimated interest expense should be included in the
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calculation of a developer’s estimated construction costs for
common improvements under the alternative cost method.
We disagree. We believe that the above specific reference
in Rev. Proc. 92-29 to section 263A(f) makes it clear that under
the alternative cost method the interest capitalization rule of
section 263A(f) applies and prevents the allocation (to a
developer’s cost bases in lots sold in a particular year) of
estimated future-period interest expense. Under section 263A(f),
only those interest expenses that are paid or incurred during the
production period are to be capitalized in the year paid or
incurred. Section 263A(f) provides in part as follows:
SEC. 263A(f) Special Rules For Allocation of Interest
to Property Produced by the Taxpayer.--
(1) Interest capitalized only in certain
cases.-–Subsection (a) shall only apply to
interest costs which are–-
(A) paid or incurred during the production
period, * * *
The “paid” or “incurred” requirement of section 263A(f)
precludes petitioners’ claim that estimated future-period
interest expense may be estimated and allocated to the basis of
lots sold in a particular year under the alternative cost method.
Our interpretation is consistent with the general economic
performance rule of section 461(g) and (h), under which interest
expense is not added to the bases of property until the expense
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is incurred. Our interpretation is also consistent with the
requirement under Rev. Proc. 92-29, 1992-1 C.B. 748, 749, that to
qualify for allocation under the alternative cost method the
“developer must be contractually obligated or required by law to
provide” the improvements relating to the estimated cost. VRI
was contractually obligated under the Contract to construct the
Golf Course and the Clubhouse. VRI, however, was not obligated
under the Contract to obtain interest-bearing debt for such
endeavor and merely chose to finance construction of the Golf
Course and the Clubhouse based on its current financial condition
and presumably could have paid off such debt at any time.4
Petitioners rely on Haynsworth v. Commissioner, 68 T.C. 703
(1977), affd. without published opinion 609 F.2d 1007 (5th Cir.
1979), in support of their position that estimated future-period
4
Rev. Proc. 92-29, sec. 2, 1992-1 C.B. 748, 749, defines
common improvements as follows:
.01 Common Improvement. For purposes of this revenue
procedure, the term “common improvement” means any real
property or improvements to real property that benefit
two or more properties that are separately held for
sale by a developer. The developer must be
contractually obligated or required by law to provide
the common improvement and the cost of the common
improvement must not be properly recoverable through
depreciation by the developer. * * * Examples of common
improvements include streets, sidewalks, sewer lines,
playgrounds, clubhouses, tennis courts, and swimming
pools that the developer is contractually obligated or
required by law to provide and the costs of which are
not properly recoverable through depreciation by the
developer.
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interest expense should be treated as estimated construction
costs and available for allocation under the alternative cost
method. In Haynsworth, the taxpayer included interest expense in
their estimate of anticipated development costs for purposes of
computing cost-of- goods-sold, but, as a result of payment of the
mortgage on the property, the taxpayer eliminated the interest
from its adjusted estimates. Petitioners claim that Haynsworth
indicates a long accepted practice of including interest expense
in the estimated costs of common improvements.
Treatment of the interest expense was not at issue in
Haynsworth. The interest expense mentioned in Haynsworth was
removed from the total estimated costs in a year before the years
in dispute. We reject petitioners’ argument that interest
expense should be included in estimated construction costs based
on Haynsworth or some accepted practice regarding estimated
interest expense.
Rev. Proc. 92-29, 1992-1 C.B. 748, provides an alternative
to the economic performance rules under section 461(h) for
determining when estimated construction costs may be included in
the bases of lots sold. In enacting the economic performance
rule, Congress was concerned that allowing taxpayers to take
current deductions for future obligations overstated the true
costs because the time value of money was not taken into account.
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See Staff of Joint Comm. on Taxation, General Explanation of the
Deficit Reduction Act of 1984, at 260 (J. Comm. Print 1984).
Rev. Proc. 92-29 provides a limited exception to section
461(h), and anything not specifically within the provisions of
Rev. Proc. 92-29 would generally be governed by the economic
performance rule of section 461(h). Rules of statutory
construction suggest that if a statute (or other authority)
specifies exceptions to a statute’s general application, other
exceptions not explicitly mentioned should not be implied. See
United States v. Lande, 968 F.2d 907, 910 (9th Cir. 1992).
We conclude that under Rev. Proc. 92-29, VRI may not include
estimated interest expense in the calculation of estimated
construction costs to be allocated to the bases in the lots VRI
sold in 1994.
To reflect the foregoing,
Decisions will be entered
under Rule 155.